Presented
in the Proceedings of the International Conference On Insurance: The Momentous
Millenium

sponsored
by the Confederation of Indian Industry

New
Delhi

November
1999

This essay will argue the thesis that the act of
selling traditional life insurance policies to individual families – the very
sale itself, quite apart from specifics of the subsequent financial performance
of the insurance policies sold – creates tangible economic value to the
families involved and to the society and economy to which they belong.It follows that a just portion of the
created value logically ought to accrue to agencies of the sale, usually
insurance agents and the companies that they represent.Furthermore, it follows that any
money’s-worth analysis of just the post-sale financial performance of the life
insurance policies sold will misrepresent the total value equation to the
families, society and economy.

If true, this
thesis calls into question many “politically correct” (or should one say
“financially correct”?) attitudes about life insurance “distribution”, its
costs and (supposed) inefficiencies, and the likely future of the world-wide
life insurance business.Indeed the
very word “distribution” tends to ascribe only passive cost characteristics
rather than active value-creation attributes to the act of selling.While the issue is most acute for the
much-maligned life insurance sales process, the thesis may apply in some measure
to sales of other forms of insurance, pensions and financial services, as well,
including social insurance and pensions and commercial privatization of
portions thereof.

It long has been
the fashion among financial journalists and analysts outside of the insurance
business, and often among participants in the business itself, to decry the
high costs associated with selling traditional life insurance policies
face-to-face by agents.Depending on
the specific product, market and company involved, the agent making a sale
might keep anywhere from 35% to 80% or more of the first year’s premium as
commission.Overrides to the people and
organizations who recruited, trained, and supported the sales agent, together
with the insurance company’s direct costs to support the sale, might consume
another 45% to 75% (or more) of the first year premium.Surely, says the fashion, there must be a
better way!

Many observers view
these costs as a pure (and regrettable) expense drain from the value of the
life insurance contract to the family who purchases it, and from the value of
the transaction to the insurance company that underwrites it.At best, the observer might ascribe some
kind of educational value to the activities of the agent, explaining the need
for and desirability of life insurance.Perhaps some additional value accrues from specific services provided,
such as helping in the selection process among complex products (and maybe
among companies), negotiating a favorable path through underwriting and rating
program alternatives, organizing the mechanics of the sale, and expediting
subsequent paperwork and enquiries.But, goes the story, any rational calculation of the value attributable
to all of these activities falls an order of magnitude short of the total
selling costs observed.The only remaining
issue is what’s to be done about this scandalous situation.

As compelling as this view seems
on the surface, it would be surprising if it represented the whole truth.In much of the world, life insurance markets
behave in highly competitive fashion and have done so for a long time, with
well-capitalized competitors who measure themselves largely by market share and
increasingly open to foreign entrants if domestic competition isn’t
enough.Furthermore, industry-wide and
worldwide the numbers of agents recruited and turned over annually are legend,
as are the energy and diversity devoted to attempts over many decades to train
and motivate agents better.Economic
theory and natural selection each demand that these competitive pressures
should have purged from the scene long ago such gross operational inefficiency
as the common wisdom ascribes to the life insurance sales process.True cartel mechanisms, even if they could
have survived for the many generations that life insurance has been sold this
way all over the world, offer no explanation for the anomaly.The preponderance of the supposed unearned
“rents” inures not to any hypothetical industry cartel, but rather to the sales
people and the organizations that support them, as varied, fractious, and
ungovernable a group as might exist anywhere in the business world.

The rejoinder to
this argument generally will point to some fundamental and systematic failure
in the market for life insurance itself as explanation for the survival of such
an inefficient sales process.The
possibilities cited might include products inherently too complex for
purchasers to understand, cash flows that only an actuary (or financial
journalist) can evaluate, lack of disclosure, absence of comparative data,
obscure sales channels, clumsy delivery vehicles, restrictive regulation,
fraudulent practices, and so on, depending upon the observer.(Does the list reveal by its very length and
variety a lack of specifically credible explanatory power?)At this point usually come the recurring
predictions of imminent demise for the traditional life insurance sales
process.The modern age offers (choose
one: direct marketing, bancassurance,
cross-selling, or – the current favorite – Internet sales) to circumvent past
market failures and save society, the insurance business and the families who
buy life insurance from the depredations of the old-fashioned life insurance
agent.

Again it would be
surprising if this “market failure” view represented the whole truth about the
remarkable historical persistence of the traditional life insurance sales
process.Some of the competing
“distribution” methodologies cited as more efficient than traditional agency
sales have had an entire generation (some of them two generations) in which to
prove their mettle.Strangely enough,
to this day they still remain hopeful contenders for future sales, not proven
heavyweights in the ring.

While direct
marketing and bancassurance have
demonstrated occasionally here and there the capacity to sell respectable
volumes of automobile, dwelling, personal accident, or term life insurance,
there is no demonstrated success for selling traditional life insurance
products this way.Apparent exceptions
to this rule (such as bancassurance
in France) always turn out to involve pre-sold products.For example, in France, the tax law
pre-sells a life insurance bond – i.e. the concept -- to everyone in the
country who is not a pauper.The vaunted
bancassurance technique simply gets
them to buy one of what they already wanted here rather than there while
banking.

Although an
enterprise can be sustained, and families helped, by selling term life
insurance through mass marketing channels, the difficulties involved should not
be ignored when judging the comparative merits with traditional sales.Considering the fairly small number
(world-wide) of direct or bank marketing efforts to sell term life that have
produced both independently successful and sizable results, after many years of
talk and effort, it might be judged even harder to succeed at than traditional
life insurance sales.Except for a
handful of world-class operators, the mass marketing approach seems to make a
lot more sense as a revenue enhancer within some other business that actually
pays the rent.

The reason may not
be far to seek.A straightforward
actuarial calculation illustrates that 20 to 30 times as much term life
insurance coverage must be sold to generate the same long run savings value to
families and society, or gross profit potential to a company, as does the sale
of traditional permanent life insurance coverage.In fairness, since term life has so much lower a premium, it will
carry more insurance coverage per sale.But it still will require selling term life to at least 5 or 6 families
in order to generate the same savings value to them and to society, or profit
potential to a company, as selling permanent life insurance to one family.These ratios need to be kept in mind when
judging the potential and the performance of any supposed new and more
effective way to sell life insurance.Is it more effective and more efficient by those orders of
magnitude?In the right circumstances
and in the hands of a superb marketing organization sometimes the answer will
be yes.But the size of the hurdle
explains why none has yet dethroned the traditional sales method in the broad
market worldwide.Internet sales are
subject to the same actuarial and economic hurdle because the hurdle derives
from the level of gross margins, not from transaction costs.

Ultimately, it
ought to surprise on sheer economic grounds if the traditional life insurance
sales process were truly as inefficient as so many observers maintain.In the long run, rewards flow with value
creation or economics doesn’t mean much.And all economic value stems from value to a customer.Successful traditional life insurance sales
people and organizations have reaped large rewards for perhaps as long a run as
any generic economic entity that is still extant in something like its original
form.Before rejecting them for some
modern thing better, it could behoove the analyst to suspend disbelief long
enough to explore seriously what large quantum of true value to life insurance
customers those benighted sales people and organizations might be about
creating, all unknown to the analytic mind these many years.

Let us consider an
emerging middle class family.Define it
to be one whose discretionary spending capacity is rising, at least a little,
compared to its own recent history.The
reason might be that the entire economy is advancing or that just the family
itself is improving its standing relative to the economy for reasons of
seniority, education, prior thrift or any other cause.On this definition, the family could live in
an emerging market or could be itself emerging within a mature or a stagnant
market.Its actual levels of income,
spending and saving could be small or large so long as discretionary spending,
at whatever level, is growing.Let us
compare the state of that family’s finances and lifestyle before and after a
successful sales call from a traditional life insurance agent.Let us also compare the state of the society
and the economy in which the family lives before and after that successful
sales call.

By definition, with
discretionary spending capacity on the rise the family’s consumption
expenditures and maybe its savings are on the rise before the agent ever
arrives at the door.If the agent is
smart and well supported by a marketing organization he won’t even knock on
doors where consumption expenditures are not rising.In fact, our family’s more recent improvements in discretionary
spending capacity probably will not yet be fully committed to new consumption
expenditures, installment payments, life-style habits, or savings levels or
programs.Maybe the family has ideas,
tentative plans or partial commitments to such.Maybe they don’t yet.But
one thing can be virtually assured.They have given no serious thought, taken no concrete steps, toward
obtaining or increasing a life insurance program, certainly not permanent life
insurance with cash values.

If the life
insurance agent doesn’t arrive, or fails to succeed, the fate of the family’s
recently enhanced discretionary spending capacity soon will be sealed.A combination of consumption expenditures or
installment payment commitments, support for more expansive life-style habits,
and (one hopes) higher commitments to ordinary savings or investment programs
will consume the new capacity.The
result for the family might be a new (or later model used) car a few years
sooner than otherwise or a better make of car.Perhaps furniture or a household appliance or entertainment unit sooner
or better than would have occurred without the new spending capacity.Most likely some marginally new habits of
entertainment or eating out or leisure or travel would develop.

For most families
such commitments and habits rapidly assume all but an irrevocable character
(excepting only for some families, alas, the savings.)These commitments and habits would fairly
soon come to immobilize the new spending capacity.Even with the purchase of durable consumer goods, within some
number of years, often small, the useful lives will have expired leaving little
or no tangible value for the expenditure made, and probably an all but
unavoidable requirement for a replacement expenditure.For non-durable goods and services, the
intangible experiential values are the only ones ever created by the
expenditure.

Savings and
investment expenditures, of course, will carry an ongoing value commensurate
with the original expenditure made, the time values expired, the risks assumed
and the fortunes experienced.This
value will be net (if you think about
it) of the implicit economic costs for the on-going option easily to liquidate
the position and spend it.And,
obviously, net of any liquidation
actually diverted to consumption purposes.It will reflect also the accumulated value of recurring savings and
investment expenditures at the same level, but
only to the extent that any recurring savings program carved out of the
original higher discretionary spending capacity has survived the human urge for
more immediate gratification.

By contrast, what
if a life insurance agent arrives before the increased discretionary spending
capacity becomes irrevocably committed?If the agent is a good one, she will probe and reveal, sometimes for the
first time even to the family themselves, the family’s hopes, fears and plans –
the inchoate ones as well as the obvious.Maybe one out of ten or fifteen times a very good agent will convert
successfully what is revealed into cool reason and emotional spark or weight in
just the right way.The family will
commit a legitimately sustainable portion of its newly available discretionary
spending capacity into recurring premium on a permanent life insurance
policy.It is not a fully rational
process.It can be exampled but not
reliably taught.It will link with
identifiable financial anticipations such as educational costs, weddings,
births or other family events, career plans, retirement plans, desire for
occupational independence, or an infinite number of other possibilities.But it will be driven by the satisfaction of
personal, social and value-laden emotional needs.

Regardless of the
experiential values achieved what economic value results for the family?Clearly, if the insured death occurs the
family is infinitely better off in a financial sense for having the policy.But they are almost always better off than
they would have been without the permanent life insurance policy even when no
death occurs.Yes, they will have
foregone a substantial premium cash flow.No, not for many years will the policy cash accumulation exceed the
investment value had the premium cash flows been faithfully saved in a
conventional savings or investment vehicle.

But that is not the
alternative.Had the family been
irrevocably committed to deploying that portion of its new discretionary
spending capacity into recurring deposits to a conventional savings or
investment vehicle, rather than into consumption, no sales person on earth
could have convinced them to divert it into permanent insurance premiums.The analysis could not have sustained the
comparison, and almost by assumption the emotional commitment could not have
been overcome by the “attraction” of a permanent life insurance premium.Had the commitment been shallow enough to be
diverted immediately into life insurance premium, then it surely would never
have withstood the ongoing human urge for diversion into consumption
expenditure.

(Another way to
view this is from an option-value perspective.The financial dynamic of a well-designed life insurance contract usually
must provide an obvious purely financial incentive to keep paying premiums once
the first year or two’s financial sacrifice has been borne.In some sense this means that the insurance
policy owner has surrendered the option to forego (sensibly) future premium
payments in favor of consumption expenditures.Compared to a recurring investment in a conventional saving or
investment program, the well-designed insurance policy after the first premium
or two rewards and will continue to reward the family that owns it for having
given over that option.Considering the
strength of the human urge to consume, especially when set in a recurring
decision context, this option must be of considerable economic value as against
an alternative less vulnerable to liquidation into ephemeral consumption.)

So the successful
life insurance sale almost certainly diverted the premium cash flows from
discretionary spending capacity that was either completely uncommitted or else
tentatively committed to consumption expenditures.If uncommitted it would most likely have found its way largely
into consumption expenditure in the end, anyway.As previously described, if put into consumption expenditure the
result for the family ultimately would have been purely experiential residual
values, at best, with no tangible residual economic value.Thanks solely to the agent’s success in
making the life insurance sale, the family has the economic values in the
insurance contract at its disposal rather than none.From the viewpoint of the family involved, the consumer against whose
viewpoint all economic value ultimately arises, the act of making that life
insurance sale created value out of nothing.Or more precisely, out of the skill and effort required to make the
sale, not least the effort required to invest time and heart in at least 9
families who did not buy before getting to the one who did.

In a phrase, the
life insurance sale is an act that converts a series of consumption
expenditures into a series of almost locked-in savings or investment
expenditures.This is inherently
valuable to the family that benefits from the resulting savings or
investments.But it is an enormously
difficult act to achieve.It compares
in no way to the much easier act of attracting expenditures already committed
to savings or investments into one vehicle rather than another.When savings or investments compete directly
with consumption it requires enormous skill and effort to bring the victory to
savings and investment.The value of
the traditional life insurance sale is in achieving that victory.

Some theoretical
niceties of utility theory may appear to cloud this conclusion as viewed at the
time of sale.But the practical view
from the time that the useful life of some durable consumption expenditure
would have expired leaves no doubt about the economic conclusion.And this is largely without regard to the
precise level of financial performance achieved under the insurance contract,
since the comparison is against zero ultimate tangible value that would have
resulted from the consumption expenditure.Even considering experiential values, the satisfactions tapped by the
good insurance agent originally to achieve the sale are likely to be of longer
duration and more human worth than the long-term residual of the experience from
most consumption expenditures.

What about the
society and economy in which the family lives?Without the life insurance sale, a series of consumption expenditures
would have ensued, or perhaps some level of savings or investment into vehicles
vulnerable to immediate redemption demands.Such vulnerability either would have precluded use of the funds for long
term fixed investment or would have allowed it only at the cost of introducing
an increment of fragility into the financial system.The preponderance of consumption expenditures makes the major
effect simply the immediate resulting stimulation of economic activity to
produce and deliver the consumables.

With the life
insurance sale, however, a series of investments ensues.The traditional life insurance sale converts
erstwhile consumption expenditures into savings and investments. Furthermore,
owing to the financial inducements built into the life insurance contract to
stay in force once sold, these investments can be deployed into long term fixed
uses without introducing nearly as much financial fragility into the economy as
would such deployment of more easily redeemable funds.Better yet, such investment flows
immediately reappear in the economy as consumption expenditures, anyway, that
is, as expenditures for the goods or services that comprise the fixed
investment project.So the life
insurance sale creates value from nothing (or, again, from the skill and effort
deployed to make the sale) for the society and economy.Namely, equivalent consumption expenditures
as would have occurred without the sale wind up stimulating demand, but on the
way they result in the creation of productive long-term assets.(Niceties of relative import content in immediate
personal consumption versus development goods may cloud the specifics of the
conclusion, but compared to no new fixed investment without the life insurance
sale the conclusion must broadly obtain.)

Finally, purely
from the moral perspective, surely the society is better off whose families
devote more of their economic priority to, and find more of their emotional
satisfaction in, caring for the long term needs and development of their
members and less in satisfying immediate consumption desires.The traditional life insurance sales process
builds upon stimulation of the former satisfactions at the expense of the
latter.

Even apart from the
societal and broad economic values involved, actually to quantify the specific
economic value created by the traditional life insurance sale for the family
involved would be highly problematic.Fortunately as in all such questions classic liberal economic theory
provides a foolproof answer.Ask the
marketplace; ask the consumer.The
value created for the family involved must be materially larger than the
rewards allowed in total to the sales agent, the supporting organizations and
the insurance company involved in the sale.After all, their total reward must be only a fraction of the value they
created for the consumer, the family involved with the sale.

But perhaps a sense for the
significance of the value created can be gleaned from the sheer difficulty of
making such a sale.What is your basic
attitude toward hearing from a life insurance sales person?Why is it that most of the carefully
screened, carefully trained, and (exorbitantly?) well rewarded life insurance
sales people who enter the profession are gone within just a couple of
years?Why is it that a typical
surviving one makes 20 or 25 unsuccessful sales calls to achieve just one
sale?Why do even the great ones
require 10 or 15 failures to achieve one success?The answer is that they create value by contravening human nature
for its own benefit.To convert
discretionary spending out of consumption and into locked-up savings or
investments is profoundly unnatural.

Remember always
that expenditures already earmarked for savings or investments rarely find
their way into traditional life insurance policies.The life insurance sales person competes with the car salesman,
the electronics emporium, the shopping mall, the travel agent, and with the
customer’s own natural inclinations, but not with the bank or mutual fund
salesperson.The traditional life
insurance sale thus creates enormous value for the family and for the society and
economy involved.High levels of reward
for those who can achieve this outcome successfully are natural and well
earned.

This is not to say
that the rewards should know no limits.Indeed, rigorous control and management is required to keep sales costs
within reasonable bounds, while still providing sufficient incentive to
motivate the difficult value creation required.It is arguable that successful management of this difficult
balance is the most important value-creating activity of life insurance company
management.By comparison, investing to
achieve a spread or providing transactional services are easy.Finding the point of low enough, but not
one-dollar lower is more art than science.Similarly, to maintain ethical standards among people whose skills run
to convincing people to do what they really didn’t start out wanting to do, to
buy something they really didn’t wake up that morning feeling they needed, is
not easy.How to be sure that they only
exert that power when it is in fact in the customer’s true interest?But to pretend that such skills properly
applied cannot create enormous value is to ignore reality.And to imagine that they can be replaced
easily by something cheap (or electronic) is pure delusion.

These extensive
ruminations have considered only the traditional life insurance arena.It may be that aspects of this way of
thinking and analyzing a sales process could provide valuable insight into the
role of commercial skills and enterprise in other insurance, pension, or financial
services.It may be that they could
offer unique insight into the value that might be provided to families and to
society by introducing commercial participation in appropriate parts of social
insurance and pension programs.